The stock market would not be complete without its set of ups and downs. These movements are completely normal, but it also vital for people to recognize appropriately which is a market correction and a bear market.
A correction might suggest that something in the market is getting fixed. However, it actually means a downbeat movement.
What is a Correction?
A market correction to put it simply, is a 10 percent pullback in the market. It is a price fall that disrupts an uptrend in the market or assert. It is a drop of a stock, bond, commodity, or a market index.
Unlike a bear market that creates a 20 percent reduction, correction generates financial loss of at least 10 percent.
Correction should not be mistaken for a bear market. Market corrections are short-term price falls that last for less than a couple of months. They also provide investors a suitable opening into stock markets, while bear markets rarely do.
Why does it happen?
Everything traded in the market never moved in a straight line; it is always either up or down. The same concept applies with their value; they will either be higher or lower.
When stocks or bond prices appear to move up endlessly, they tend to become overbought. This signals some investors to acquire the surge of prices, expecting to profit from it before it collapse.
Investors who purchased earlier, helping bolster prices will then think about selling when they believe the price is close to a peak.
They might base their decision on any type of bad news that may cause a sell-off. It could be an earnings report of a stock with flat financial results, or a thought that a business will face a problem.
In some instances, investors will just take profits as the market gets intense. Either way, the selling pressure weighs prices down.
Is it healthy for the market?
Although seeing an account balance lose about 10 percent could be unsightly and may feel uncomfortable, corrections are in fact, good for both the market and investors.
Corrections help cools down an overheated stock or bond market, so as to prevent a big sell-off or a bubble burst. They are believed to modify prices to their real value or support levels so that they are overpriced or inflated.
For investors, it helps them see how well-adjusted they really are with market risk as well as with making changes to their portfolio when necessary. Corrections also allow investors to include companies at discounted prices.
What to do when there is a market correction?
When a correction occurs there are some simple steps to take:
- Be patient
- Do not follow what your instincts say
- Keep a broad mind
- Do not get greedy or afraid
- Work with your financial advisor
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